Tax-Deferred Investing – Benefits and Considerations
Tax-efficient investing may seem complicated, but carefully reviewing your investment products and accounts could lead to improved after-tax returns – potentially the difference between meeting long-term goals or falling short of them.
Tax-deferred investments allow earnings such as interest, dividends and capital gains to accumulate without being subject to taxes until withdrawn – providing many advantages and considerations, including:
Immediate Tax Relief
Tax-deferred investments offer numerous advantages, from immediate tax relief to increased compounding growth potential.
Tax-deferred accounts may be suitable for you depending on your current tax bracket, retirement plans and future income levels. However, if you anticipate being in a higher tax bracket in the future or prefer investments without any taxable consequences such as non-tax deferred accounts may prove more suitable.
Tax-deferred investing options typically available to us include employer-sponsored retirement plans such as 401(k)s and traditional IRAs, 529 college savings plans and some life insurance policies. Keep in mind, however, that contributions and withdrawals have limits and penalties may apply so it is wise to consult a Thrivent financial advisor when reviewing options available to you.
Long-Term Growth Potential
Tax efficiency is an integral component of financial planning and investing. While taxes shouldn’t drive investment decisions, understanding how to manage, defer and reduce federal income taxes will help keep more of your hard-earned dollars invested and working for you over time.
Tax-deferred investments offer several key advantages, primarily lowering your taxable income for the year while enabling earnings to accrue tax-free until retirement – increasing long-term growth potential considerably.
Tax-deferred investments offer significant compounding effects over time. To take full advantage of their power, consult with a Thrivent financial advisor about designing an investment strategy tailored to your goals and timeline.
Withdrawals Are Taxed as Ordinary Income
Tax deferred investments allow investors to postpone paying taxes until withdrawal. This feature is particularly attractive in retirement savings accounts such as 401(k)s and IRAs, but may also apply to some annuities and health savings accounts. When choosing tax-deferred investments for yourself, keep your goals, timeline, risk tolerance and tax considerations all in mind; factoring them in will help ensure more efficiently reaching them.
However, it is important to be mindful that when withdrawing assets they will be taxed as ordinary income and early withdrawals from tax-deferred accounts such as Traditional IRAs could incur an early withdrawal penalty of 10% on top of income taxes and could reduce returns overall.
The Rule of 72
Navigating the murky waters of investments can be daunting, so keeping tax efficiency top of mind will help ensure sound financial decisions and maximize long-term wealth potential.
One of the key concepts to comprehend when dealing with compound interest is the Rule of 72, a formula designed to estimate when an initial investment will double its value. Simply put, this calculation helps estimate how long it will take an investment to grow exponentially in value.
To use the formula, divide 72 by the expected annual return for an investment. For instance, if your initial investment is expected to produce an 8% yield over five years, according to this formula it should double every nine years.
This calculation does not take into account factors like investment fees, expenses and federal/state taxes; however it illustrates how compounding can speed up the growth of your initial investment and help you reach your financial goals more quickly.
